Rob Enderle, 15th August 2012

Rumors of a $200 Microsoft Surface Tablet have likely prompted a number of corporate bigwigs - from Apple to PC OEMs - to experience unpleasant chest pains in recent days.

On paper Microsoft certainly could meet a $200 price point, helping Redmond steal much of the market from Apple in the 4th quarter - especially if they ran their $200 10” Tablet against Apple’s rumored $250 7” tablet.

This would also significantly offset what I believe may turn out to be a strategic mistake on the part of Microsoft by not having an
inexpensive 7” tablet version - particularly when Amazon is poised to launch up to three Fires in that size while Google's Neuxs 7 sells out and Apple preps its iPad Mini.

While I think releasing a $200 tablet would break too many eggs, it might also corner the market, so let’s
talk about how Redmond might do it. I’m not saying they will - mind you - in fact I really think they won’t, but heck, I figure this will be an interesting analysis in any case. Remember, to accomplish this feat, Microsoft would need to apply a combination of smartphone and Xbox subsisides, all while sharing them with the other tablet builders. So let’s do the math.

BOM Cost

The Bill of Materials cost for the iPad 2 was $326.60 back in March of 2011. Given the typical decline
of component costs, it is likely approaching or hovering around $300 today. Assuming Microsoft was to build the same quality and promise a similar quantity, we have a starting point of $300. For a price at break even, you’d add in costs for marketing, packaging, and distribution (likely about $50) and you’d end up with a hard cost of $350.

This means you’d have to recover $150 in subsidies - which is in line with both the subsidies from cellular companies for smartphones. For example, an unlocked HTC Nexus is $330 while the same handset with a subsidy from T-Mobile is between $99 and $149 - depending on who you buy it from.

If you recall, back in 2006 Microsoft subsidized the Xbox 360 to the tune of $76 while Sony subsidized the PlayStation at a whopping $240-$307. Either one can get us to the $150 we need, while combining both models would exceed the required amount. This is definitely a positive thing, as it is quite doubtful that a smartphone carrier would offer the same funds to subsidize a tablet - even if 4G networking is enabled.

OEMs

The issue isn’t whether Microsoft can get there, they clearly can. Rather, the problem is upsetting the OEMs who have promised to deliver their own tablets to market and this is where things get dicey. Now the OEMs (Dell, Lenovo etc.) could certainly get the same carrier subsidies that Microsoft does but, at best, they are likely only $74 and unlike Microsoft, they’ll still need to find a profit.

Breaking even won’t impress management and that means the company would have to share in the app store royalties and revenue. Redmond wouldn’t give it all to them, simply because Microsoft is carrying the cost of the OS and the app store in this scenario - so they would likely only pass on about half. This means they would have to pull out $150 for each device in royalties to give the OEMs the $75 they need. While Microsoft could drop this all the way down to $25, this is still $100 in royalties and we are still just at break even, we haven’t even gotten to profit yet.

Now using a similar model, Amazon's Kindle is estimated to provide the online retailer with 10% of its revenue or close to $100M annually from about 5M Kindles (that’s the regular Kindle not the Kindle Fire) so a Kindle provides about a $20 per year ongoing subsidy just for books. A $20 per year annuity is worth about $200 today, which certainly shows we are in the ballpark, and you’d think a tablet would be able to generate more than $20 per year.

So this would give you $100 profit per tablet (using just books and the $200 target plus additional carrier
subsidy). And the OEM would be more than happy with a $100 profit on a $300 device (33%) given
many are now getting below 20%.

Wrapping UP: $200 Windows RT Tablet Unlikely

While we can get there in terms of raw theoretical math, the sheer complexity of the revenue transfers, marketing co-op dollars and all the rest would likely make a product at this price point virtually impossible.

Right now I place the likelihood of Windows RT tablets below $500 at .9, below $400 at .6, below $300 at .3, and below $200 at .1 or one chance out of ten. Still, if Microsoft pulled it off, they could corner the market for tablets in the critical 4th quarter, likely crater Apple’s stock, surprise Google, and actually have a good response for the 7” iPad and other small tablets likely to be the most popular during the holiday season.

Yes, stranger things have happened, but I just don’t think they will this year.